1 SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-Q X Quarterly report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 For the quarterly period ended September 30, 1999 or Transition report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 For the transition period from _________ to __________ Commission file number 2-77519-LA SARATOGA BANCORP (Exact name of registrant as specified in its charter) California 94-2817587 (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification No.) 12000 Saratoga-Sunnyvale Road Saratoga, California 95070 (Address of principal executive offices) (Zip Code) Registrant's telephone number including area code (408) 973-1111 NONE (Former name, former address and former fiscal year, if changed since last report) Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes X No Indicate the number of shares outstanding of each of the issuer's classes of common stock as of the latest practicable date. CLASS SHARES OUTSTANDING AT OCTOBER 8, 1999 Common Stock 1,586,588 Exhibit Index at Page 29 Page 1 of 30 pages 2 PART I - FINANCIAL INFORMATION Item 1. Consolidated Condensed Financial Statements SARATOGA BANCORP AND SUBSIDIARY CONSOLIDATED CONDENSED BALANCE SHEETS September 30, December 31, 1999 1998* (Unaudited) ASSETS Cash and due from banks $ 5,561,000 $ 6,549,000 Federal funds sold 24,600,000 14,450,000 Total cash and equivalents 30,161,000 20,999,000 Interest bearing deposits in other banks 1,792,000 1,789,000 Securities available for sale 31,424,000 30,811,000 Securities held to maturity 10,586,000 9,304,000 Loans, net 65,905,000 73,847,000 Premises and equipment 4,530,000 2,268,000 Other assets 7,300,000 5,784,000 -------------- -------------- TOTAL ASSETS $ 151,698,000 $ 144,802,000 ============== ============== LIABILITIES Deposits: Non interest-bearing $ 24,639,000 $ 27,460,000 Interest-bearing 87,746,000 75,955,000 -------------- -------------- Total deposits 112,385,000 103,415,000 Federal funds purchased - 2,000,000 Other borrowings 22,571,000 22,697,000 Accrued expenses and other liabilities 1,669,000 1,433,000 -------------- -------------- TOTAL LIABILITIES 136,625,000 129,545,000 SHAREHOLDERS' EQUITY Common stock, no par value; Authorized: 20,000,000 shares; Issued and outstanding: 1,586,588 shares at September 30, 1999 and 1,629,357 shares at December 31, 1998 4,434,000 4,684,000 Retained earnings 11,184,000 10,591,000 Accumulated other comprehensive income (loss) net of taxes of $313,000 and $11,000, respectively (545,000) (18,000) -------------- ------------- TOTAL SHAREHOLDERS' EQUITY 15,073,000 15,257,000 -------------- ------------- TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $151,698,000 $ 144,802,000 ============== ============= *Derived from the December 31, 1998 audited balance sheet included in the Company's 1998 Annual Report on Form 10-K. See notes to consolidated condensed financial statements. 3 SARATOGA BANCORP AND SUBSIDIARY CONSOLIDATED CONDENSED STATEMENTS OF INCOME AND COMPREHENSIVE INCOME (Unaudited) Three Months Ended Nine Months Ended September 30, September 30, 1999 1998 1999 1998 INTEREST INCOME: Loans $1,705,000 $1,665,000 $5,170,000 $4,759,000 Investment securities 635,000 593,000 1,889,000 2,039,000 Federal funds sold 244,000 238,000 565,000 531,000 ---------- ---------- ---------- ---------- Total interest income 2,584,000 2,496,000 7,624,000 7,329,000 ---------- ---------- ---------- ---------- INTEREST EXPENSE: Deposits 809,000 781,000 2,384,000 2,224,000 Other 343,000 353,000 1,017,000 1,058,000 ---------- ---------- ---------- ---------- Total interest expense 1,152,000 1,134,000 3,401,000 3,282,000 ---------- ---------- ---------- ---------- NET INTEREST INCOME BEFORE PROVISION FOR CREDIT LOSSES 1,432,000 1,362,000 4,223,000 4,047,000 Provision for credit losses - 34,000 66,000 136,000 ---------- ---------- ---------- ---------- Net interest income after provision for credit losses 1,432,000 1,328,000 4,157,000 3,911,000 Other income 404,000 201,000 912,000 493,000 Other expenses 1,083,000 767,000 2,811,000 2,272,000 ---------- ---------- ---------- ---------- INCOME BEFORE INCOME TAXES 753,000 762,000 2,258,000 2,132,000 Provision for income taxes 267,000 290,000 824,000 810,000 ---------- ---------- ---------- ---------- NET INCOME 486,000 472,000 1,434,000 1,322,000 OTHER COMPREHENSIVE INCOME, NET OF TAX: Unrealized gains (losses) on securities (108,000) 314,000 (527,000) 353,000 ---------- ----------- ---------- ---------- COMPREHENSIVE INCOME $ 378,000 $ 786,000 $ 907,000 $1,675,000 ========== =========== ========== ========== EARNINGS PER SHARE: Basic $ 0.31 $ 0.29 $ 0.90 $ 0.80 ========== =========== ========== ========== Diluted $ 0.27 $ 0.26 $ 0.80 $ 0.72 ========== =========== ========== ========== See notes to consolidated condensed financial statements. 4 SARATOGA BANCORP AND SUBSIDIARY CONSOLIDATED CONDENSED STATEMENTS OF CASH FLOWS (Unaudited) Nine Months Ended September 30, 1999 1998 OPERATIONS: Net income $1,434,000 $ 1,322,000 Adjustments to reconcile net income to net cash provided by operating activities: Provision for credit losses 66,000 136,000 Depreciation and amortization 388,000 174,000 Gain on sale of leased assets 33,000 - Other, net 260,000 441,000 ----------- ----------- Net cash provided by operating activities 2,181,000 2,073,000 ----------- ----------- INVESTING ACTIVITIES: Net increase in interest bearing deposits in other banks (3,000) (5,300,000) Proceeds from maturities or sale of investments available for sale 4,293,000 22,258,000 Proceeds from maturities of investments held to maturity 600,000 3,012,000 Purchase of securities available for sale (5,722,000) (8,000,000) Purchase of securities held to maturity (1,895,000) (2,985,000) Purchase of life insurance policies (1,238,000) (3,892,000) Net decrease (increase) in loans 7,876,000 (3,224,000) Purchases of premises and equipment (3,164,000) (516,000) Proceeds from sale of premises and equipment 481,000 - ----------- ----------- Net cash provided by investing activities 1,228,000 1,353,000 ----------- ----------- FINANCING ACTIVITIES: Net increase in deposits 8,970,000 9,372,000 Issuance of common stock 35,000 32,000 Repurchase of common stock (807,000) - Payment of cash dividends (319,000) (276,000) Net decrease in other borrowings (126,000) (245,000) Decrease in federal funds purchased (2,000,000) (2,000,000) ----------- ----------- Net cash provided by financing activities 5,753,000 6,883,000 ----------- ----------- NET INCREASE IN CASH AND EQUIVALENTS 9,162,000 10,309,000 Cash and equivalents, beginning of period 20,999,000 15,260,000 ----------- ----------- Cash and equivalents, end of period $30,161,000 $25,569,000 =========== =========== See notes to consolidated condensed financial statements. 5 SARATOGA BANCORP AND SUBSIDIARY NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS SEPTEMBER 30, 1999 AND 1998 1. The unaudited consolidated condensed financial statements reflect all adjustments (which include only normal recurring adjustments) which are, in the opinion of management, necessary to state fairly the results for the periods presented. The results for the periods are not necessarily indicative of the results to be expected for the full fiscal year. 2. Basic Earnings Per Share is computed by dividing net income by the weighted average common shares outstanding during the period. Diluted Earnings Per Share reflects the potential dilution if securities or other contracts to issue common stock are exercised or converted into common stock. Diluted earnings per share is computed by dividing net income by the average shares outstanding for the period plus the dilutive effect of stock options. The weighted average shares used in computing earnings per share are as follows: Quarters ended September 30, 1999 1998 Weighted average shares used in computing: Basic earnings per share 1,587,000 1,646,000 Diluted potential common shares from exercise of stock options, using the treasury stock method 203,000 183,000 --------- --------- Diluted earnings per share 1,790,000 1,829,000 --------- --------- Nine Months ended September 30, 1999 1998 Weighted average shares used in computing: Basic earnings per share 1,594,000 1,644,000 Diluted potential common shares from exercise of stock options, using the treasury stock method 188,000 180,000 --------- --------- Diluted earnings per share 1,782,000 1,824,000 6 3. In 1998, the Company adopted SFAS No. 131, "Disclosures about Segments of an Enterprise and Related Information",which establishes annual and interim reporting standards for an enterprise's operating segments and related disclosures about its products, services, geographic areas and major customers. Management has determined that since all of the commercial banking products and services offered by the Bank are available in each branch of the Bank, all branches are located within the same economic environment and management does not allocate resources based on the performance of different lending or transaction activities, it is appropriate to aggregate the Bank's operations into a single operating segment. 4. Effective July 1, 1998 the Company adopted Statement of Financial Accounting Standards (SFAS) No. 133, "Accounting for Derivative Instruments and Hedging Activities", which establishes accounting and reporting standards for derivative instruments and hedging activities. In connection with the adoption of SFAS 133 the Company reclassified certain securities with an amortized cost of $19,751,000 and a fair value of $19,967,000 from held-to- maturity to available-for-sale. Adoption of this statement did not have any other impact on the Company's consolidated financial position and had no impact on the Company's results of operations or cash flows. 5. During the nine months ended September 30, 1999 and 1998, cash paid for taxes was $526,000 and $709,000, respectively. During the nine months ended September 30, 1999 and 1998, cash paid for interest was $3,273,000 and $3,119,000, respectively. 7 SARATOGA BANCORP AND SUBSIDIARY Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations. Certain matters discussed or incorporated by reference in this Quarterly Report on Form 10-Q are forward-looking statements that are subject to risks and uncertainties that could cause actual results to differ materially from those projected. Changes to such risks and uncertainties, which could impact future financial performance, include, among others, (1) competitive pressures in the banking industry; (2) changes in interest rate environment; (3) general economic conditions, nationally, regionally and in operating market areas; (4) changes in the regulatory environment; (5) changes in business conditions and inflation; (6) changes in securities markets; and (7) Year 2000 compliance problems. Therefore, the information set forth herein should be carefully considered when evaluating business prospects of the Company and the Bank. SUMMARY OF FINANCIAL RESULTS At September 30, 1999, total assets were $151,698,000, an increase of $6,896,000 (4.8%) from $144,802,000 at December 31, 1998. Net loans decreased $7,942,000 (10.8%) from $73,847,000 at December 31, 1998 to $65,905,000 at September 30, 1999. Total deposits increased $8,970,000 (8.7%) from $103,415,000 at December 31, 1998 to $112,385,000 at September 30, 1999. Net income for the third quarter of 1999 was $486,000 ($0.31 basic earnings per share, $0.27 diluted earnings per share) compared to $472,000 ($0.29 basic earnings per share, $0.26 diluted earnings per share) for the comparable period in 1998. Net income for the first nine months of 1999 was $1,434,000 ($0.90 basic earnings per share, $0.80 diluted earnings per share) compared to $1,322,000 ($0.80 basic earnings per share, $0.72 diluted earnings per share) for the comparable period in 1998. Return on Average Assets was 1.29% on an annualized basis for the first nine months of 1999 compared to 1.36% for the comparable period in 1998. Return on Average Equity was 12.59% for the first none months of 1999 compared to 12.46% for the comparable period in 1998. The increase in income resulted primarily from an increase in the volume of earning assets, offset in part by an increase in interest expense due to the increased volume of interest-bearing liabilities. 8 RESULTS OF OPERATIONS THIRD QUARTER OF 1999 AND 1998 An analysis of the results of operations of the Company for the third quarter of 1999 compared to the third quarter of 1998 is presented below: Net interest income Net interest income, the difference between interest earned on loans and investments and interest paid on deposits, is the principal component of the Bank's earnings. The components of net interest income are as follows: 9 Three months ended September 30, 1999 1998 Average Average Average Average Balance Interest Yield(1) Balance Interest Yield(1) (In thousands, except percentages)(unaudited) Assets: Earning assets: Loans (2) $ 69,654 $1,705 9.8% $66,033 $1,665 10.1% Investment securities 42,845 609 5.7 37,313 533 5.7 Federal funds sold 18,813 244 5.2 17,099 238 5.6 Interest bearing deposits 1,741 26 6.0 4,132 60 5.8 -------- ------ -------- ------ Total interest earning assets 133,053 2,584 7.8 124,577 2,496 8.0 Cash and due from banks 6,499 5,235 Other assets (3) 10,245 3,533 -------- -------- $149,797 $133,345 ======== ======== Liabilities and Shareholders' Equity: Interest-bearing liabilities: Demand deposits $ 48,457 354 2.9 $ 39,813 331 3.3 Time deposits 36,095 455 5.0 31,328 450 5.7 Other borrowings 22,600 343 6.1 22,872 353 6.2 -------- ------ -------- ----- Total interest- bearing liabilities 107,152 1,152 4.3 94,013 1,134 4.8 Demand deposits 25,813 22,924 Other liabilities 1,729 1,659 -------- -------- Total liabilitie 134,694 118,596 Shareholders' equity 15,103 14,749 -------- -------- $149,797 $133,345 ======== ======== Net interest income and margin(4) $1,432 4.3% $1,362 4.4% ====== ====== (1) Annualized. (2) Loan interest income includes loan fee income of $131,000 for the quarters ended September 30, 1999 and 1998, respectively. (3) Net of the average allowance for loan losses of $827,000 and $722,000 and deferred loan fees of $370,000 and $324,000 for the quarters ended September 30, 1999 and 1998, respectively. (4) Net interest margin is computed by dividing net interest income by total average interest earning assets. 10 PROVISION FOR CREDIT LOSSES The Bank maintains an allowance for possible credit losses which is based, in part, on the Bank's historical loss experience, the impact of forecasted economic conditions within the Bank's market area, and, as applicable, the State of California, the value of the underlying collateral, loan performance and inherent risks in the loan portfolio. The allowance is reduced by charge- offs and increased by provisions for credit losses charged to operating expense and recoveries of previously charged-off loans. During the third quarter of 1999, the Bank did not record a provision for credit losses. During the third quarter of 1998, the Bank provided $34,000 for the allowance for credit losses. There were no loans charged-off and $14,000 in recoveries in the third quarter of 1999, as compared to no loans charged-off and $8,000 in recoveries in the third quarter of 1998. At September 30, 1999, the allowance for credit losses was $840,000 or 1.26% of total loans, compared to $716,000 or 0.96% at December 31, 1998. There were no nonaccrual loans at September 30, 1999 or December 31, 1998. At September 30, 1999 and December 31, 1998, there were no loans past due 90 days or more as to principal or interest and still accruing interest. There were no loans at September 30, 1999 which were troubled debt restructurings as defined in Statement of Financial Accounting Standards No. 15, "Accounting by Debtors and Creditors for Troubled Debt Restructuring." At September 30, 1999, there were three potential problem loans having a combined principal balance of $1,431,000 ($259,000 at December 31, 1998). Potential problem loans are loans which are generally current as to principal and interest but have been identified by the Company as potential problem loans due either to a decrease in the underlying value of the property securing the credit or some other deterioration in the creditworthiness of the borrower. All of the three loans identified as potential problem loans are secured by real estate and personal property. There was no Other Real Estate owned ("OREO")at September 30, 1999 or December 31, 1998 Nonperforming loans and other real estate owned are summarized below: September 30, 1999 December 31, 1998 Nonperforming loans: Past due 90 days or more $ - $ - Nonaccrual - - --------- --------- Total - - Other real estate owned - - --------- --------- Total nonperforming loans and other real estate owned $ - $ - ========= ========= 11 Management is of the opinion that the allowance for credit losses is maintained at an adequate level for known and inherent risks in the loan portfolio. However, the Bank's loan portfolio, which includes approximately $49,000,000 in real estate loans representing approximately 74% of the portfolio, could be adversely affected if California economic conditions and the real estate market in the Bank's market area weaken. The effect of such events could result in an increase in the level of nonperforming loans and OREO and the resultant necessary level of the allowance for loan losses which could adversely affect the Company's and the Bank's future growth and profitability. NONINTEREST INCOME Other income consists of service charges on deposit accounts, income from assets acquired for lease, increases in the cash surrender value of life insurance policies and fees for other miscellaneous services. Total other income increased from $201,000 in the third quarter of 1998 to $404,000 in the third quarter of 1999. This increase is primarily attributable to a gain on sale of OREO of $62,000, an increase of $58,000 in cash surrender value of life insurance policies and an increase in rental income on assets acquired for lease of $137,000. NONINTEREST EXPENSES Other expenses increased from $767,000 in the third quarter of 1998 to $1,083,000 in the third quarter of 1999. The increase is primarily attributable to an increase in depreciation expense on assets acquired for lease of $112,000, an increase in deferred compensation expense of $55,000 and merger-related expenses of $134,000. As a percentage of average earning assets, other expense for the third quarter, on an annualized basis increased from 2.5% in 1998 to 3.3% in 1999. NINE MONTHS ENDED SEPTEMBER 30, 1999 AND 1998 An analysis of the results of operations of the Company for the nine month period ended September 30, 1999 compared to the comparable period in 1998 is as follows: NET INTEREST INCOME Net interest income, the difference between interest earned on loans and investments and interest paid on deposits, is the principal component of the Bank's earnings. The components of net interest income are as follows: 12 Nine months ended September 30, 1999 1998 Average Average Average Average Balance Interest Yield(1) Balance Interest Yield(1) (In thousands, except percentages)(unaudited) Assets: Earning assets: Loans (2) $ 72,764 $5,170 9.5% $ 63,999 $4,759 9.9% Investment securities 42,736 1,809 5.6 42,686 1,932 6.0 Federal funds sold 15,331 565 4.9 12,887 531 5.5 Interest bearing deposits 1,833 80 5.8 2,405 107 5.9 -------- ------ -------- ------ Total interest earning assets 132,664 7,624 7.7 121,977 7,329 8.0 Cash and due from banks 6,487 5,056 Other assets (3) 9,062 3,043 -------- -------- $148,213 $130,076 ======== ======== Liabilities and Shareholders' Equity: Interest-bearing liabilities: Demand deposits $ 45,240 983 2.9 $ 38,951 964 3.3 Time deposits 36,645 1,401 5.1 29,366 1,260 5.7 Other borrowings 22,664 1,017 6.0 22,892 1,058 6.2 -------- ------ -------- ------ Total interest- bearing liabilities 104,549 3,401 4.3 91,209 3,282 4.8 Demand deposits 26,800 23,286 Other liabilities 1,679 1,434 -------- -------- Total liabilities 133,028 115,929 Shareholders' equity 15,185 14,147 -------- -------- $148,213 $130,076 ======== ======== Net interest income and margin(4) $4,223 4.2% $4,047 4.4% ====== ====== (1) Annualized. (2) Loan interest income includes loan fee income of $318,000 and $338,000 for the nine months ended September 30, 1999 and 1998, respectively. (3) Net of the average allowance for loan losses of $777,000 and $666,000, and deferred loan fees of $320,000 and $320,000 for the nine months ended September 30, 1999 and 1998, respectively. (4) Net interest margin is computed by dividing net interest income by total average interest earning assets. 13 PROVISION FOR CREDIT LOSSES During the first nine months of 1999, the Bank recorded a $66,000 provision for loan losses as compared to $136,000 during that period in 1998. There were no loans charged-off and $58,000 in recoveries for the nine months ended September 30, 1999, compared to $14,000 in loans charged off and $40,000 in recoveries for the first nine months of 1998. NONINTEREST INCOME Other income consists of service charges on deposit accounts, income on assets acquired for lease, increases in the cash surender value of life insurance policies and fees for other miscellaneous services. Total other income increased from $493,000 in 1998 to $912,000 in 1999. The increase is primarily attributable to an increase in rental income on assets acquired for lease of $272,000, recognition of a gain on sale of OREO of $62,000 and an increase of $163,000 in cash surrender value of life insurance policies. NONINTEREST EXPENSES Other expenses have increased from $2,272,000 in 1998 to $2,811,000 in 1999 due primarily to an increase in depreciation expense on leased assets of $217,000, an increase in deferred compensation expense of $150,000 and merger related expenses of $134,000. As a percentage of average earning assets, other expenses, on an annualized basis, increased from 2.5% in 1998 to 2.8% in 1999. INVESTMENT PORTFOLIO The amortized cost and fair values of securities are as follows: September 30, December 31, 1999 1998 (in thousands) Securities Available for Sale Amortized Fair Amortized Fair Cost Value Cost Value U.S. Treasury and agency securities $18,222 $17,786 $14,890 $14,972 Mortgage-backed securities 8,053 7,861 10,665 10,657 Governmental mutual fund 3,128 2,898 3,128 3,025 Federal Home Loan Bank stock 2,529 2,529 2,007 2,007 Bankers Bank stock 350 350 150 150 ------- ------- ------- ------- Total $32,282 $31,424 $30,840 $30,811 ======= ======= ======= ======= 14 Securities Held to Maturity Amortized Fair Amortized Fair Cost Value Cost Value Obligations of states and political subdivisions $10,496 $ 9,985 $ 9,214 $ 9,384 Federal Reserve Bank stock 90 90 90 90 ------- ------- -------- -------- Total $10,586 $10,075 $ 9,304 $ 9,474 ======= ======= ======== ======== As investment securities mature, to the extent that the proceeds are reinvested in investment securities, management expects that the categories of taxable investment securities purchased will be in approximately the same proportion as existed at September 30, 1999. The maturities and yields of the investment portfolio at September 30, 1999 and December 31, 1998 are shown below. MATURITY AND YIELDS OF INVESTMENT SECURITIES At September 30, 1999 (Dollars in thousands) Securities Available for Sale Estimated After 1 Year & After 5 years & After 10 Fair Within 1 Year Within 5 Years Within 10 Years years Value Amount Yield(1)AmountYield(1) AmountYield(1)AmountYield(1) U.S. Treasury and agency securities $17,786 $1,001 5.40% $9,168 5.92% $2,862 6.08% $4,755 5.97% Governmental mutual fund 2,898 2,898 6.72 - - - - - - Federal Home Loan Bank 2,529 - - - - - - 2,529 5.88 stock Bankers Bank stock 350 - - - - - - 350 - ------- ------ ----- ------ ----- ------ ----- ------ ----- 23,563 $3,899 6.38% $9,168 5.92% $2,862 6.08% $7,634 5.67% ====== ====== ====== ====== Mortgage- backed securities(2) 7,861 -------- Total $ 31,424 ======== 15 Securities Held to Maturity Total After 1 Year & After 5 Years & After Carrying Within 1 Year Within 5 Years Within 10 Years 10 Years Value AmountYield(1)AmountYield(1)AmountYield(1) AmountYield(1) Obligations of states and political subdivisions $10,496 $660 4.51% $1,523 4.58% $1,298 4.64% $7,015 5.13% Federal Reserve Bank stock 90 90 6.00 ------- ---- ------ ------ ------ Total $10,586 $660 4.51% $1,523 4.58% $1,298 4.64% $7,105 5.14% ======= ==== ====== ====== ====== (1) Yields are actual, not fully taxable equivalent. (2) Mortgage-backed securities generally have stated maturities of 4 to 15 years but are subject to likely and substantial prepayments which effectively accelerate actual maturities. MATURITY AND YIELDS OF INVESTMENT SECURITIES At December 31, 1998 (Dollars in thousands) Securities Available for Sale EstimatedAfter 1 Year & After 5 years & After Fair Within 1 Year Within 5 Years Within 10 Years 10 years Value AmountYield(1) AmountYield(1) AmountYield(1)AmountYield(1) U.S. Treasury and agency securities $14,972 $ 18 5.51% $8,913 5.95% $1,000 6.10% $5,041 5.98% Governmental mutual fund 3,025 3,025 6.12 - - - - - - Federal Home Loan Bank 2,007 - - - - - - 2,007 5.12 stock Bankers Bank stock 150 - - - - - - 150 - ------- ------ ------ ------ ------ 20,154 $3,043 6.11% $8,913 5.95% $1,000 6.10% $7,198 5.62% ====== ====== ====== ====== Mortgage- backed securities(2) 10,657 ------- Total $30,811 ======= 16 Securities Held to Maturity Total After 1 Year &After 5 Years & CarryingWithin 1 Year Within 5 YearsWithin 10 YearsAfter 10 Years Value Amount Yield(1)AmountYield(1)AmountYield(1)AmountYield(1) Obligations of states and political subdivisions 9,214 450 5.31% 1,902 4.55% 1,418 4.73% 5,444 4.93% Federal Reserve Bank stock 90 90 6.00 ------ --- ------ ------ ------ Total $9,304 $450 5.31% $1,902 4.55% $1,418 4.73% $5,534 4.95% ====== ==== ====== ====== ====== (1) Yields are actual, not fully taxable equivalent. (2) Mortgage-backed securities generally have stated maturities of 4 to 15 years but are subject to likely and substantial prepayments which effectively accelerate actual maturities. LOAN PORTFOLIO The composition of the loan portfolio at September 30, 1999 and December 31, 1998 is summarized in the following table. September 30, December 31, 1999 1998 (in thousands) Real estate: Construction $12,668 $19,623 Other 36,698 33,452 Commercial 14,936 18,738 Installment 1,016 1,192 Lease financing 1,766 1,850 Deferred loan fees (339) (292) ------- ------- Subtotal 66,745 74,563 Allowance for Credit losses (840) (716) ------- ------- Loans, net $65,905 $73,847 ======= ======= 17 ALLOWANCE FOR CREDIT LOSSES Activity in the allowance for credit losses for the nine months ended September 30, 1999 and the year ended December 31, 1998 is summarized in the following table: Nine months Year ended ended September 30, December 31, 1999 1998 ------------- ------------ Beginning balance $ 716,000 $ 578,000 Provision charged to operations 66,000 136,000 Charge-offs - Commercial - (65,000) Recoveries - Commercial 58,000 67,000 --------- --------- Ending balance $ 840,000 $ 716,000 ========= ========= Ratio of net charge-offs (recoveries) during the period to average loans outstanding (annualized for the nine months ended September 30, 1999). (.106)% (.003)% ========= ========= Ratio of allowance for credit losses to loans outstanding at end of period 1.26% 0.96% ========= ========= DEPOSITS The average balance sheets for 1999 and 1998 set forth the average amount and average interest rate paid for deposits. At September 30, 1999 and December 31, 1998, time deposits of $100,000 or more have remaining maturities as follows (in thousands): September 30, December 31, ------------- ------------ 3 months or less $14, 739 $ 6,640 Over 3 months to 6 months 2,727 8,959 Over 6 months to 12 months 3,442 4,583 Over 1 year to 5 years 2,436 2,497 Over 5 years 100 100 -------- ------- TOTAL $ 23,444 $22,779 ======== ======= 18 LIQUIDITY AND CAPITAL RESOURCES The Bank manages its liquidity to provide adequate funds at an acceptable cost to support borrowing requirements and deposit flows of its customers. At September 30, 1999 liquid assets as a percentage of deposits were 56% (52% at December 31, 1998). In addition to cash and due from banks, liquid assets include short-term time deposits with other banks, Federal funds sold and investment securities available for sale. The Bank has $11.0 million in Federal funds lines of credit available with correspondent banks to meet liquidity needs. Management regularly reviews general economic and financial conditions, both external and internal, and determines whether the positions taken with respect to liquidity and interest rate sensitivity continue to be appropriate. The Bank also utilizes a monthly "Gap" report which identifies rate sensitivity over the short- and long-term. The following table sets forth the distribution of repricing opportunities, based on contractual terms, of the Company's earning assets and interest-bearing liabilities at September 30, 1999, the interest rate sensitivity gap (i.e. interest rate sensitive assets less interest rate sensitive liabilities), the cumulative interest rate sensitivity gap, the interest rate sensitivity gap ratio (i.e. interest rate sensitive assets divided by interest rate sensitive liabilities) and the cumulative interest rate sensitivity gap ratio. 19 DISTRIBUTION OF REPRICING OPPORTUNITIES At September 30, 1999 (Dollars in thousands) After Three After Six After One Within Months But Months But Year But After Three Within Six Within One Within Five Months Months Year Five Years Years Total --------- ---------- ----------- ---------- -------- -------- Federal funds sold $24,600 - - - - $24,600 Interest bearing deposits in other banks - 200 1,294 298 - 1,792 Municipal securities - - 660 1,523 8,313 10,496 U.S. Treasury and agency securities 3,900 - - 12,030 4,755 20,685 Mortgage-backed securities - 239 - 1,261 6,361 7,861 FRB/FHLB stock - - - - 2,969 2,969 Loans 27,198 4,114 1,198 12,935 21,640 67,085 -------- ------- -------- ------- ------- -------- Total earning assets $55,698 $ 4,553 $ 3,152 $28,047 $44,038 $135,488 -------- ------- -------- ------- ------- -------- Interest bearing demand accounts $41,277 - - - - 41,277 Savings accounts 11,064 - - - - 11,064 Time certificates of deposit of $100,000 or more 14,739 2,727 $ 3,442 2,436 100 23,444 Other time deposits 4,311 1,938 3,643 2,069 - 11,961 Other borrowings 25 2,000 - 12,484 8,062 22,571 ------- ------- -------- ------- -------- ------- Total interest- bearing liabilities $71,416 $ 6,665 $ 7,085 $16,989 $ 8,162 $110,317 ------- ------- -------- ------- -------- -------- Interest rate sensitivity gap $(15,718) $(2,112) $ (3,933) $11,058 $35,876 $ 25,171 ======== ======= ======== ======= ======= ======== Cumulative interest rate sensitivity gap $(15,718) $(17,830) $(21,763) $(10,705) $25,171 ======== ======== ======== ======== ======= Interest rate sensitivity gap ratio 0.78 0.68 0.44 1.65 5.40 Cumulative interest rate sensitivity gap ratio 0.78 0.77 0.74 0.90 1.23 20 The Company and the Bank are subject to capital adequacy guidelines issued by the Board of Governors of the Federal Reserve System (the "BGFRS") and the Office of the Comptroller of the Currency ("OCC"). The Company and the Bank are required to maintain total capital equal to at least 8% of assets and commitments to extend credit, weighted by risk, of which at least 4% must consist primarily of common equity including retained earnings (Tier 1 capital) and the remainder may consist of limited life (and in the case of banks, cumulative) preferred stock, mandatory convertible securities, subordinated debt and a limited amount of loan loss reserves. Effective October 1, 1998, the BGFRS and other federal agencies approved including in Tier 2 capital up to 45% of the pretax net unrealized gains on certain available-for-sale equity securities having readily determinable fair values (i.e. the excess, if any, of fair market value over the book value or historical cost of the investment security). The federal regulatory agencies reserve the right to exclude all or a portion of the unrealized gains upon a determination that the equity securities are not prudently valued. Unrealized gains and losses on other types of assets, such as bank premises and available-for-sale debt securities, are not included in Tier 2 capital, but may be taken into account in the evaluation of overall capital adequacy and net unrealized losses on available- for-sale equity securities will continue to be deducted from Tier 1 capital as a cushion against risk. Certain assets and commitments to extend credit present less risk than others and will be assigned to lower risk-weighted categories requiring less capital allocation than the 8% total ratio. For example, cash and government securities are assigned to a 0% risk-weighted category, most home mortgage loans are assigned to a 50% risk-weighted category requiring a 4% capital allocation and commercial loans are assigned to a 100% risk-weighted category requiring an 8% capital allocation. As of September 30, 1999, the Company's total risk-based capital ratio was approximately 17.0 (approximately 16.7% for the Bank) compared to approximately 16.8% (approximately 16.4% for the Bank) at December 31, 1998. The Board of Governors and other federal banking agencies have adopted a revised minimum leverage ratio for bank holding companies and banks as a supplement to the risk-weighted capital guidelines. The old rule established a 3% minimum leverage standard for well-run banking organizations (bank holding companies and banks) with diversified risk profiles. Banking organizations which did not exhibit such characteristics or had greater risk due to significant growth, among other factors, were required to maintain a minimum leverage ratio 1% to 2% higher. The old rule did not take into account the implementation of the market risk capital measure set forth in the federal regulatory agency capital adequacy guidelines. The revised leverage ratio establishes a minimum Tier 1 ratio of 3% (Tier 1 capital to total assets) for the highest rated bank holding companies and banks. All other bank holding companies must maintain a minimum Tier 1 leverage ratio of 4% with higher leverage capital ratios required for banking organizations that have significant financial and/or operational weaknesses, a high risk profile, or are undergoing or anticipating rapid growth. 21 The following table reflects the Company's leverage, Tier 1 and total risk- based capital ratios as of September 30, 1999 and December 31, 1998. September 30, 1999 December 31, 1998 ------------------ ----------------- Leverage ratio 10.2% 11.0% Tier 1 capital ratio 16.1% 16.0% Total risk-based capital ratio 17.0% 16.8% On December 19, 1991, the President signed the Federal Deposit Insurance Corporation Improvement Act of 1991 (the "FDICIA"). The FDICIA, among other matters, substantially revised banking regulations and established a framework for determination of capital adequacy of financial institutions. Under the FDICIA, financial institutions are placed into one of five capital adequacy catagories as follows: (1) "Well capitalized" - consisting of institutions with a total risk-based capital ratio of 10% or greater, a Tier 1 risk-based capital ratio of 6% or greater and a leverage ratio of 5% or greater, and the institution is not subject to an order, written agreement, capital directive or prompt corrective action directive; (2) "Adequately capitalized" - consisting of institutions with a total risk-based capital ratio of 8% or greater, a Tier 1 risk-based capital ratio of 4% or greater and a leverage ratio of 4% or greater, and the institution does not meet the definition of a "well capitalized" institution; (3) "Undercapitalized" - consisting of institutions with a total risk-based capital ratio less than 8%, a Tier 1 risk-based capital ratio of less than 4%, or a leverage ratio of less than 4%; (4) "Significantly undercapitalized" - consisting of institutions with a total risk-based capital ratio of less than 6%, a Tier 1 risk-based capital ratio of less than 3%, or a leverage ratio of less than 3%; (5) "Critically undercapitalized" - consisting of an institution with a ratio of tangible equity to total assets that is equal to or less than 2%. Financial institutions classified as undercapitalized or below are subject to various limitations including, among other matters, certain supervisory actions by bank regulatory authorities and restrictions related to (i) growth of assets, (ii) payment of interest on subordinated indebtedness, (iii) payment of dividends or other capital distributions, and (iv) payment of management fees to a parent holding company. The FDICIA requires bank regulatory authorities to initiate corrective action regarding financial institutions which fail to meet minimum capital requirements. Such action may result in orders to, among other matters, augment capital and reduce total assets. Critically undercapitalized financial institutions may also be subject to appointment of a receiver or implementation of a capitalization plan. OTHER MATTERS The Registrant and San Jose National Bank issued a joint press release dated August 27, 1999, announcing the signing of an Agreement and Plan of Merger dated August 27, 1999 (the "Agreement"), by and among SJNB Financial Corp, Saratoga Bancorp and Saratoga National Bank. Pursuant to the agreement, 22 Saratoga Bancorp will merge with and into SJNB Financial Corp in a tax-free merger intended to be accounted for as a pooling of interests (the"Merger") with outstanding shares of Saratoga Bancorp converted into 0.7 of a share of SJNB Financial Corp., subject to adjustment, and Saratoga National Bank will merge with and into San Jose National Bank, a subsidiary of SJNB Financial Corp. The agreement includes among its terms, the grant of a stock option to SJNB Financial Corp. to acquire up to 19.9% of the outstanding Saratoga Bancorp shares upon the occurance of certain events pursuant to a Stock Option Agreement dated as of August 27, 1999. The Merger is subject to the approval of Saratoga Bancorp and SJNB Financial Corp. shareholders and applicable regulatory approvals. YEAR 2000 As the year 2000 approaches, a critical issue has emerged regarding how existing application software programs and operating systems can accommodate this date value. In brief, many existing application software products were designed to only accommodate a two digit date position which represents the year (e.g. "97" is stored on the system and represents the year 1997.) As a result, the year 1999 (i.e. "99") could be the maximum date value these systems will be able to accurately process. This is not just a banking problem, as corporations around the world and in all industries are similarly impacted. During 1997, the Company began a plan that includes the five phases of Year 2000 compliance as defined by the FFIEC (i.e. awareness, assessment, renovation, validation, and implementation). The Company's Year 2000 Plan (the "Plan") addresses the proper function of the Company's in-house computer hardware and software, along with other products and services which the Company utilizes and which have potential for Year 2000 difficulties. Awareness and Assessment Phases The Company completed the Awareness and Assessment Phases, as defined by the FFIEC, during early 1998 and continues to update its assessment as needed. Management of the Company reports at least monthly to the Board of Directors on its Year 2000 efforts. Renovation Phase The FFIEC guideline date for institutions to substantially complete program changes and system upgrades for mission critical systems was December 31, 1998. By that date, the Company had completed replacements of all hardware and software components with the exception of the item processing subsystem of the mainframe. The replacement of this system was completed in March 1999. Validation and Implementation Phases To reduce the possibility of unexpected failure of the Company's systems during and after the century date change, which could have an impact on the Company and its customers, the company continues to test its systems in accordance with a test strategy and plan developed in 1998. The FFIEC guideline date for institutions to begin testing their mission critical applications and systems was September 1, 1998. 23 During April 1998, the Company began testing various mission critical and non-mission critical systems. The Company had completed this testing by the end of the second quarter of 1999. Business Relationships As a part of the Company's Plan, all third party suppliers and service providers have been contacted and assessed as to their Year 2000 preparedness. In addition, the Bank has communicated with its large borrowers and major depositors to determine the extent to which the Company might be vulnerable if those third parties fail to resolve their Year 2000 issues. Because the Company recognizes that its business and operations could be adversely affected if key businesses fail to achieve timely Year 2000 compliance, the Company is evaluating strategies to manage and mitigate the risk to the Company from their Year 2000 failures. Contingency Plans FFIEC guidelines indicate that contingency plans covering mission critical systems in the event of Year 2000 problems are a prudent business practice. The Company has developed contingency plans for applications and systems used by the Bank that are deemed mission critical as well as plans to cover many non-mission critical applications and systems. The contingency plans are based on a review of various emergency scenarios ranging from the Year 2000 failure of a single software or hardware component to the total loss of systems and applications. Because business resumption planning is a dynamic process, the Company may further refine and test these plans throughout 1999. Costs to Address Year 2000 Issues The majority of the costs associated with the Company's Year 2000 preparedness efforts would have been incurred in the normal course of business, as the Company regularly upgrades its various systems in an effort to more efficiently and effectively serve its clientele and conduct its operations. The Company estimates the total cost of compliance will be approximately $150,000, with the majority of this expense earmarked for the new item processing subsystem. The costs incurred in 1998 did not have a material effect on the Company's net income for 1998, and the Company does not expect the costs that will be incurred in 1999 to have a material impact on the Company's net income for 1999. Even with all of the Company's preparation, there can be no assurance that problems will not arise which could have an adverse impact due, among other matters, to the complexities involved in computer programming related to resolution of Year 2000 problems and the fact that the systems of other companies on which the Company may rely must also be corrected on a timely basis. Delays, mistakes or failures in correcting Year 2000 system problems by such other companies could have a significant adverse impact upon the Company and its ability to mitigate the risk of adverse impact of Year 2000 problems for its customers. 24 Quantitative and Qualitative Disclosures about Market Risk Disclosures under this item are not required for the current fiscal year as the Company qualifies as a "Small Business" filer. PART II - OTHER INFORMATION Item 1. Legal Proceedings Not applicable Item 2. Changes in Securities Not applicable Item 3. Defaults upon Senior Securities Not applicable Item 4. Submission of Matters to a Vote of Security Holders Not applicable Item 5. Other Information Not applicable Item 6. Exhibits and Reports on Form 8-K a) (3) Exhibits. The exhibits listed on the accompanying Exhibit Index are filed as part of this report. (3.1) Articles of Incorporation, as amended, are incorporated by reference herein to Exhibit 3.1 of Registrant's Annual Report on Form 10-K for the fiscal year ended December 31, 1988, as filed with the Securities and Exchange Commission on March 27, 1989. (3.2) By-laws, as amended, are incorporated by reference herein to Exhibit 3.2 of Registrant's Annual Report on Form 10-K for the fiscal year ended December 31, 1993 as filed with the Securities and Exchange Commission on March 29, 1994. 25 (4.1) Specimen stock certificate is incorporated by reference to Exhibit 4.1 of Registrant's Annual Report on Form 10-K for the fiscal year ended December 31, 1994 as filed with the Securities and Exchange Commission on March 30, 1995. (10.1) Lease agreement dated 10/19/87 for 15405 Los Gatos Blvd., Suite 103, Los Gatos, CA is incorporated by reference herein to Exhibit 10.1 of Registrant's Annual Report on Form 10-K for the fiscal year ended De cember 31, 1987 as filed with the Securities and Exchange Commission on March 31, 1988. (10.2) Agreement of Purchase and Sale dated July 27, 1988 for 12000 Saratoga-Sunnyvale Road, Saratoga, CA is incorporated by reference herein to Exhibit 10.1 of Registrant's Annual Report on Form 10-K for the fiscal year ended December 31, 1988, as filed with the Securities and Exchange Commission on March 27, 1989. *(10.3) Indemnification Agreements with directors and executive officers of the Registrant are incorporated by reference herein to Exhibit 10.2 of Registrant's Annual Report on Form 10-K for the fiscal year ended December 31, 1988, as filed with the Securities and Exchange Commission on March 27, 1989. (10.4) Lease agreement dated 1/17/89 for 160 West Santa Clara Street, San Jose, California is incorporated by reference herein to Exhibit 10.4 of Registrant's Annual Report on Form 10-K for the fiscal year ended December 31, 1989, as filed with the Securities and Exchange Commission on March 27, 1990. (10. 5) Bank of the West Master Profit Sharing and Savings Plan and Amendment, amended as of March, 1990, are incorporated by reference herein to Exhibit 10.5 of Registrant's Annual Report on Form 10-K for the fiscal year ended December 31, 1990, as filed with the Securities and Exchange Commission on March 20, 1991. *(10.6) Chief Executive Officer Compensation Plan/Richard L. Mount is incorporated by reference herein to Exhibit 10.6 of Registrant's Annual Report on Form 10-K for the fiscal year ended December 31, 1990, as filed with the Securities and Exchange Commission on March 20, 1991. 26 *(10.7) Saratoga Bancorp 1982 Stock Option Plan is incorporated by reference herein to the exhibits to Registration Statement No.33-34674 on Form S-8 as filed with the Securities and Exchange Commission on May 7, 1990. *(10.8) Saratoga National Bank Savings Plan dated June 19, 1995 is incorporated by reference herein to Exhibit 10.8 of Registrant's Annual Report on Form 10-K for the fiscal year ended December 31, 1995, as filed with the Securities and Exchange Commission on March 27, 1996. *(10.9) Saratoga Bancorp 1994 Stock Option Plan dated March 18, 1994 is incorporated by reference herein to Appendix A of Proxy Statement dated April 19, 1994 as filed with the Securities and Exchange Commission on April 27, 1994. *(10.10) Forms of Incentive Stock Option Agreement, Non-Statutory Stock Option Agreement and Non-Statutory Agreement for Outside Directors, as amended is incorporated by reference herein to Exhibit 10.8 of Registrant's Quarterly Report on Form 10-Q for the Quarter ended June 30, 1994 as filed with the Securities and Exchange Commission on August 15, 1994. *(10.11) Form of Director Supplemental Compensation Agreement dated September 24, 1998 between Saratoga National Bank and Robert G. Egan, John F. Lynch III and V. Ronald Mancuso, respectively. *(10.12) Form of Director Life Insurance Endorsement Method Split Dollar Plan Agreement dated September 24, 1998 between Saratoga National Bank and Robert G. Egan, John F. Lynch III, and V. Ronald Mancuso, respectively. *(10.13) Form of Director Surrogate Supplemental Compensation Agreement dated September 24, 1998 between Saratoga National Bank and Victor E. Aboukhater and William D. Kron, respectively. *(10.14) Form of Director Surrogate Life Insurance Endorsement Method Split Dollar Plan Agreement dated September 24, 1998 between Saratoga National Bank and Victor E. Aboukhater and William D. Kron, respectively. 27 *(10.15) Form of Officer Supplemental Compensation Agreement dated September 24, 1998 between Saratoga National Bank and Earl Lanna, Mary Rourke, Sandra Swenson, Barbara Resop and Cathe Franklin, respectively. *(10.16) Form of Officer Life Insurance Endorsement Method Split Dollar Plan Agreement dated September 24, 1998 between Saratoga National Bank and Earl Lanna, Mary Rourke, Sandra Swenson, Barbara Resop and Cathe Franklin, respectively. *(10.17) Richard L. Mount Executive Supplemental Compensation Agreement dated September 24, 1998. *(10.18) Richard L. Mount Life Insurance Endorsement Method Split Dollar Plan Agreement dated September 24, 1998. *(10.19) Richard L. Mount Employment Agreement dated May 20, 1999, effective January 1, 1999. *(10.20) Richard L. Mount Executive Benefits Agreement dated June 18, 1999. (27.1) Financial Data Schedule *Denotes management contracts, compensatory plans or arrangements. (b) Reports on Form 8-K ------------------- On September 23, 1999, Registrant filed a Current Report on Form 8-K, dated September 20, 1999 reporting under Item 5 (Other Events) a ten cent ($0.10) cash dividend on outstanding shares of common stock of Saratoga Bancorp, to be payable on November 5, 1999, to shareholders of record at the close of business on October 22, 1999. On September 1, 1999, Registrant filed a current Report on Form 8-K, dated August 30, 1999, reporting under Item 5 (Other Events) that The Registrant and SJNB Financial Corp. issued a joint press release dated August 27, 1999, announcing the signing of an Agreement and Plan of Merger dated August 27, 1999 (the "Agreement"), by and among SJNB Financial Corp, Saratoga Bancorp and Saratoga National Bank. Pursuant to the agreement, Saratoga Bancorp will merge with and into SJNB Financial Corp 28 in a tax-free merger in intended to be accounted for as a pooling of interests (the"Merger") with outstanding shares of Saratoga Bancorp converted into 0.7 of a share of SJNB Financial Corp., subject to adjustment, and Saratoga National Bank will merge with and into San Jose National Bank, a subsidiary of SJNB Financial Corp. The agreement includes among its terms, the grant of a stock option to SJNB Financial Corp. to acquire up to 19.9% of the outstanding Saratoga Bancorp shares upon the occurance of certain events pursuant to a Stock Option Agreement dated August 27, 1999. The Merger is subject to the approval of Saratoga Bancorp and SJNB Financial Corp. shareholders and applicable regulatory approvals. SIGNATURES PURSUANT TO THE REQUIREMENTS OF THE SECURITIES EXCHANGE ACT OF 1934, THE REGISTRANT HAS DULT CAUSED THE REPORT TO BE SIGNED ON BEHALF BY THE UNDERSIGNED THEREUNTO DULY AUTHORIZED. SARATOGA BANCORP Date: October 18, 1999 MARY PAGE ROURKE ----------------- Mary Page Rourke (Principal Accounting Officer) 29 INDEX TO EXHIBITS ----------------- Sequentially Numbered Number Exhibits Page - ------ --------- -------------- 27.1 Financial Data Schedule 30